I'm thinking the taxability of the home is separate from the Sch A medical expense deduction.  If he doesn't qualify to exclude the gain because he did not live in the home for two of the last five years, then all the $23,000 would be taxable.  However, even if the gain is not taxable, he didn't get to keep the money.  All the $23,000 went to WI, so does he have a $23,000 medical expense?